Components of an Option

When purchasing a car, you likely want to know a wide range of details: horsepower, fuel economy, if it has a CD player, air conditioning, and so on. Some prices are no doubt fixed, while others may be flexible. Knowing what is included with the purchase will help you to calculate if the deal is good or not. You may even go to some type of ‘black book’ that will then estimate fair value.

The same is true with options. When we understand what components go into an options contract, we are better able to know if a certain option is a good purchase. There are fixed and standardised components to an options contract and flexible or variable ones.

Standardised Option Components

Underlying Asset

Size of Contract

Expiration Date

Exercise Price

Non-Standardized Option Component

Option Premium (or cost)

Options Component: Underlying Asset

Not every stock and security is available to purchase or write options on. You cannot pick a random penny stock and expect to buy a call options contract on it. Many of the ASX top 100 stocks listed in the ASX 100 index are option-able and listed here.

Another way to find ASX stocks with options is to follow the link here to the ASX website. There you will have the ability to download a PDF format list of all tradable options. Keep in mind that all available options on a specific security regardless of strike price and time until expiration will be termed a class. For instance, all options on AWC is one class, and all options available for BHP is another.

Options Component: Size of Contract

In the ASX, the amount of shares represented with each options contract is 1,000. This differs from the North American market of 100 shares per options contract.
Index options have a price per index point. Each point on the index is generally worth $10. This means that an index trading at 5,000 points will have a options contract value of $50,000 ($10 x 5,000 points).

Asset Size

Options Contract Size

Value

3,000 index points

1 ($10 per point)

$30,000

5,000 stock shares

5

5,000 x Share Price

120,000 stock shares

120

120,000 x Share Price

Options Component: Expiration Date

Options have a specific date that either the contract is exercised by or it expires worthless. Remember that an options contract is only the right to own shares, but this right is time sensitive.

When purchasing an option, you will need to pick an expiration month. The options contract will come due generally on the Thursday before the last Friday of the month for an equity type of Exchange Traded Option. For index options, the third Thursday of the specified month is when the contract will expire. It is important to note that American option types can be traded at any time while European types can only be exercised on the expiration date.

You can view the futures and options expiration calendar for 2010 and 2011 as examples. It is best to verify expiration dates on an official calendar instead of relying on your own calculations as the Australian Clearing House reserves the rights to change these dates.

Options Component: Exercise Price

The exercise price is the same as the strike price. When the underlying asset matches or exceeds this value, the option holder can convert the contract into actual shares. The strike prices are set by the ACH and not by the option writer.

The exercise price does not need to be met for a trader to profit. Even if the share value goes in the desired direction, but still not to the strike price, you can sell your options contract for a profit to another market speculator.

Viewing the options available on ticker symbol AGK shows a 50 cent spread between the strike prices or exercise values with this options class. Depending on the security, the offered strike prices may vary

Options Component: Premiums

Premiums refer to the amount of money paid for an options contract. This value will fluctuate depending on a variety of variables such as interest rates, historic price volatility, anticipation of a future move, liquidity, and so forth.

To know whether you are paying a fair price on the options premium, you can use an options calculator to determine market value. A theoretical options calculator is available at the ASX website. More will be discussed on premiums later.